Africa Upfront gives you the opinions and analysis of PwC experts on the current Africa agenda.

Brexit – weathering the storm in South Africa

14 July 2016

By Dr Roelof Botha, Economic Advisor to PwC South Africa

In the aftermath of a raft of media commentary and expert analyses of the likely long-term implications of the Brexit referendum vote, it’s fairly clear that the level of global socio-economic and political uncertainty has been raised.

Short-term volatility

As a general rule, members of the global equity investment fraternity are wary of undue uncertainty. This has been vividly illustrated by declining equity market prices across the globe and currency weakness in Europe in the immediate aftermath of the narrow majority vote for the UK to exit the European Union (EU).

Much of the equity market losses outside of Europe have, however, been recouped since the referendum. It’s important to note that global investment funds haven’t dried up, but are simply being diverted to so-called safe haven destinations, including precious metals and US bonds.

Several economic research agencies have warned against exaggerating the anticipated economic impact of the referendum result. Due to its unprecedented nature, short-term volatility of key indicators was predictable, but financial markets are bound to come to grips with the reality that Britain will remain an integral and pivotal part of Europe.

Economic prowess

The UK is classified by the International Monetary Fund as a major advanced economy and is a member of the seven most influential countries in the world (the G-7 group). It also enjoys a per capita GDP of $44,000, which is more than four times higher than the world average. Furthermore, currency depreciation has automatically lifted the competitiveness of the British economy, which borrows in its own currency and doesn't have much to fear from liquidity constraints.

There will be significant uncertainty over the coming months as the detailed political and legal issues are worked out, and business confidence may be impacted. In due course, markets are likely to develop a greater understanding of two key aspects of Brexit that are likely to assist a return to greater financial and currency stability.

Firstly, it’ll take several years to complete the arduous legal and administrative processes required for the exit from the EU. Literally thousands of existing treaties and regulations that impact on UK businesses need to be nullified, but many of them will eventually be re-negotiated.

One of the uncontested tenets of economic theory is that international trade benefits both participants, be they individual countries or regions. Norway represents an informative case study of a country that’s not a member of the EU. While not a member of the European Union, in return for access to many of the economic privileges of EU membership, they agree to abide by the internal market’s rules, such as social or environmental legislation, and pay smaller contributions than EU members.

Potential for deregulation

A second issue that elucidates the outcome of the referendum vote is the zealousness with which the EU has drawn up thousands of new regulations and directives, particularly over the last six years.

Lobby groups such as Open Europe and Business for Britain have pointed out that many of the EU regulations impose a cost on business that’s not always matched by tangible benefits. Open Europe has estimated that the 100 most expensive EU regulations represent a substantial net cost to the UK economy, based on the analysis of 2,500 impact assessments of the benefits and costs of EU regulations.

When taking the sheer volume of EU restrictions imposed on business processes into account, it’s clear that significant benefits stand to be reaped from the process of reviewing EU regulation that could follow Britain’s exit from the EU. However, the detailed legal issues are far from being worked out to be certain to say it would result in wholesale removal of regulations previously enforced. Even if current regulations were removed, UK business may still have to comply with alternatives, particularly if trading within the EU.

Positive news for goldApart from an initial element of currency volatility and a drop in the equity prices of domestic firms with strong ties to Britain, in the near term, South Africa has much to gain from Brexit:

Firstly, the gold price, which had already started a new upward price cycle early in 2016, has received a strong boost since 23 June, rising to its highest level in more than two years. Increased uncertainty in financial markets means that safe haven assets (such as gold) should stay in demand well into the future. In the aftermath of Brexit, several authoritative economic research agencies are predicting a continuation of the extraordinary low interest rate environment in Europe, the US and other advanced economies, which will further enhance the attractiveness of gold, to the benefit of the South African mining industry.

Secondly, the impact of the Brexit vote on Sterling, and its knock-on impacts on the Euro could, in the near term at least, assist the quest for price stability in South Africa, where inflation recently crept up to above the central bank’s target range. Cheaper rand denominated imports from Europe, which is a dominant trading region, are likely to lead to significantly lower inflation during the second half of 2016, which could halt the upward trend in money market interest rates and possibly also witness a lowering of the prime overdraft rate.

Thirdly, South Africa is in a good position to benefit from future bilateral trade and investment agreements with Britain, mainly as a result of its historically strong economic ties with the UK and its status as a gateway for business into sub-Saharan Africa. South Africa remains the most competitive economy on the African continent and boasts superior infrastructure and financial market development to most other emerging markets.

One potential downside of a stronger rand (vs. European currencies) is the likelihood of lower export earnings, but this should be countered by the newfound upward phase of metal and mineral commodities, which are mostly traded in US dollars.

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